The Relationship of Bond Risk and Return
The normal relationship is that an investor who takes higher risk demands a higher return.
- Higher Risk = Higher Return / Yield
- Lower Risk = Lower Return /Yield
From this, we can see that risk-free bonds such as those issued or guaranteed by the Government offer the lowest yields, while more risky bonds issued by corporations will offer higher yields. For corporate bonds, the rating scale from rating agencies measures the riskiness of the bond.
For example:
- AAA = Lowest risk corporate, lower return /yield
- B = Higher risk corporate, higher return / yield
The yield curve is the starting point for every investor. One must study the yield curves first before deciding if a bond offers an attractive yield given its risk and tenor.
